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Traders Could Book 15% Gains in This Housing Stock in Q2

The housing market keeps improving, and for traders, many of the stocks pegged to housing's fortunes continue to deliver. The latest round of positive metrics in the space came this week, as home prices in January posted their best annual gains since summer 2006. According to the Standard & Poor's/Case-Shiller Home Price Index for 20 leading cities, January prices rose 8.1% from the same month a year ago.

On the flipside, we also found out that new-home sales in February fell 4.6% from January. While this isn't what housing bulls would like to see, considering that January's sales had been the strongest since September 2008, a decline was expected.

So far in 2013, the SPDR S&P Homebuilders (NYSE: XHB), an exchange-traded fund (ETF) that holds the biggest housing stocks in the nation, is up about 10%. The real fireworks, however, are within the stocks in the space.

Year to date, the big housing stock winner is KB Home (NYSE: KBH), which has seen a 34% price spike in the first quarter of 2013. And while this move higher is impressive, for traders looking to get in on housing stocks right now, I think KBH is likely too overbought here to support another significant move up.

Other stalwarts in the space actually have sold off during the past three months, including MDC Holdings (NYSE: MDC), down 3.4%, Beazer Homes (NYSE: BZH), off 8.9%, and Hovnanian (NYSE: HOV), which has tumbled 21.3% year to date. Apparently, a rising tide doesn't float all boats, so I would avoid these housing stocks for now as well.

For traders, I think the key to continuing to profit from the housing boom is to find the stock in the space that has strong fundamentals but hasn't been bid up too far yet.

Enter D.R. Horton (NYSE: DHI).

The Texas-based homebuilder seems to be in the sweet spot for traders, both in terms of outstanding fundamentals and its technical picture.

On the fundamental front, D.R. Horton closed on nearly 20,000 homes in 2012, more than any other homebuilder. The company also has been furiously investing in land to make sure it has plenty of areas to continue building. It has strong pricing power, with an average closing price in the last quarter of $236,000, up 10% from the prior year.

In fiscal Q1, which ended Dec. 31, Horton reported a gross profit margin of 18.8%, as selling prices rose in excess of costs. The company also saw pretax income surge some 270% from the same quarter a year ago to $107.9 million. Earnings per share (EPS) spiked 122% to $0.20, making it the most profitable first quarter for the company since 2007, before the housing collapse.

Technically speaking, DHI stock is up big in 2013, but not so much that I think it's overextended at current levels. Despite a year-to-date rise of 19%, the stock hasn't vaulted too far from its 50-day moving average. Moreover, the shares now appear to be trading in the "handle" portion of a bullish cup-and-handle base pattern.

DHI Stock Chart

I suspect that ongoing strength in the housing space, and Horton's ability to take advantage of that strength, will help propel DHI stock higher from current levels -- and that makes this housing stock a good place to build trading profits.

Recommended Trade Setup:

-- Buy DHI at the market
-- Set stop-loss at $22.29, approximately 8% below the current price
-- Set initial price target at $27.93 for a potential 15% gain in the next quarter